Trade in value added: how Global Value Chains affect competitiveness

Europe Economics Blog

Oct 31, 2017

1.1 Measuring external competitiveness

The issue of external competitiveness has always been an important topic in the economic and political discourse of the European Union.[1] In this respect, in 2010 the European Commission launched the Europe 2020 strategy aiming at transforming the EU into “a smart, sustainable and inclusive economy, delivering high levels of employment, productivity and social cohesion.” Similar to the Lisbon Strategy which ended in 2010, the Europe 2020 strategy is driven by international competitiveness concerns and the promotion of productivity, growth and sustainability.

An accurate assessment of international competitiveness is therefore particularly important for achieving the objectives of Europe 2020 as well as gaining the most from Brexit (both form an EU and UK perspective) as it allows both the ex-ante evaluation of potential impacts of policies and the identification of trends calling for policy action. The vast majority of existing studies on the determinants of the external position of a country have focused on the supply side of the economy, attributing movements in performance (e.g. export market shares) to cost-oriented drivers, such as unit labour costs (ULCs) and real effective exchange rates (REER).[2]

From this perspective, one of the most commonly used indicators is a country’s share of world exports. For example, growth in market share over a five-year is one of the indicators taken into account in the European Commission’s Macroeconomic Imbalances Procedure.[3] A recurring finding when using such indicators is that rich countries have been steadily losing market share in favour of emerging countries, particularly China, since 2001 (Figure 1).

Figure 1: Market shares of gross exports

However, evidence from trade data has revealed several unexpected patterns which challenge the suitability of competitiveness indicators based on gross exports. The heightened extent of international fragmentation of production and the emergence of global value chains (GVCs) with intensive intra-industry trade suggests that indicators of competitiveness need to account for other dimensions since a country's exports may, for instance, considerably rely on imported intermediate inputs.[4] In fact, a country with a high global market share in a given sector is not necessarily highly competitive in this sector if a large part of the value added of these exports is generated elsewhere by means of intermediate goods.

1.2 The challenges posed by Global Value Chains

The process of producing goods, from raw materials to final products, is increasingly carried out wherever the necessary skills and materials are available at competitive cost and quality. Therefore, the fact that a product is finalised in a particular country does not necessarily mean that domestic firms are governing the value chain. Similarly, trade in services is essential for the efficient functioning of GVCs, not only because services link activities across countries but also because they help companies to increase the value of their products.

In the EU, for instance, roughly 30 per cent of the value added embodied in extra-EU exports of EU countries is of foreign origin, i.e. not generated in the exporting country itself.[5] However, this trend is not the same for all countries. As shown by Figure 1, since 1995 the foreign value added content in total exports has risen faster in Germany (+71%), France (+53%), Italy (+48%) and Japan (+224%) than in the United States (+34%) and the United Kingdom (+20%). In contrast, China shows a decreasing trend (-5%).

Figure 2: Foreign value-added share of gross exports

An often-cited case study that clearly illustrates the issue relates to the production of Apple’s iPods, which are assembled in China. Although iPods being sold in the US count as a Chinese export to the US, a study showed that of the $144 factory-gate price of an iPod in China, less than 10 per cent reflected value added generated in China.[6] This is due to the fact that the bulk of the components are imported from Japan, Korea and the US itself.

The key concerns that GVCs pose to standard trade statistics can therefore be summarised as follows:[7]

Exports increasingly embody intermediate inputs sourced from abroad, thus hindering the assessment of the true contribution that exports make to the economy. The need to account for foreign intermediate inputs becomes particularly more pronounced in developed economies, where a large share of the total value added generated by manufactured exports originates in the services sector.

Production could be fragmented internationally even within a multinational enterprise. As a result, part of the value-added may be repatriated to the parent company.

1.3 Ongoing research initiatives

In the last years, a number of initiatives have been put in place to address these issues, including the development of international input-output tables that can be used to calculate the domestic and foreign content of bilateral trade flows.

In particular, the OECD has been undertaking comprehensive statistical and analytical work aimed at shading light on the scale, nature and consequences of international production fragmentation. This includes the joint OECD – WTO Trade in Value-Added (TiVA) initiative which addresses the issue by considering the value added by each country in the production of goods and services that are consumed worldwide.

Similarly, the World Input-Output Database (WIOD) project that is being undertaken by a consortium of 11 institutions (including OECD) and funded by the European Union, developed intercountry tables covering 43 countries (including the EU28), and a model for the rest of the world for the period 2000-2014.

With the globalization of production, there is a growing awareness that conventional trade statistics may give a misleading perspective of the importance of trade to economic growth and income. Initiatives like TiVA and WIOD are of key importance to researchers and governments as to inform policy actions aimed at improving a country’s competitive position.